BREAKINGVIEWS - Facebook's market meltdown is far from over

A Facebook application logo is pictured on a mobile phone in this photo illustration taken in Lavigny May 16, 2012.

Reuters/Valentin Flauraud/Files

(The following column appears in the Aug. 6 issue of Newsweek magazine. The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

By Rob Cox

NEW YORK Aug 6 (Reuters Breakingviews) - It would be all too easy to wager that Facebook's (FB.O) market meltdown could be coming to an end. After all, the social network led by Mark Zuckerberg in just a couple of months incinerated as much as $50 billion of shareholders' wealth. To put that in context, even after a recent rebound, Facebook since its Nasdaq debut in May has lost value nearly equal to the current market capitalizations of Yahoo (YHOO.O), AOL (AOL.N), Zynga (ZNGA.O), Yelp (YELP.N), Pandora (P.N), OpenTable OPEN.O, Groupon (GRPN.O), LinkedIn (LNKD.N) and Angie's List (ANGI.O) combined, plus that of the bulk of the publicly traded newspaper industry.

As shocking as this utter failure may come to the nearly 1 billion faithful Facebook users around the world, it's no surprise at all to anyone who read the initial public offering prospectus. Worse still, all the red flags that were flying when the company debuted - overpriced shares, shoddy corporate governance, huge challenges to the core business and a damaged brand - remain at full mast today. In this respect, Facebook looks like a proverbial example of what's known on Wall Street as a falling knife - that is, one that can cost investors their fingers if they try to catch.

Start with the valuation. To justify a stock price close to the lower end of the projected range in the IPO, say $28 a share, Facebook's future growth needed to mirror that of Google's (GOOG.O) seven years earlier, according to an analysis by Reuters Breakingviews and Anant Sundaram, a professor at Dartmouth's Tuck School of Business. Under that scenario, Facebook would have had to increase revenue over the next couple of years by some 80 percent annually, while maintaining high profit margins all the while.

That's not happening. In the first half of 2012, Facebook reported revenue of $2.24 billion, up 38 percent from the same period in 2011. At the same time, the company's costs surged to $2.6 billion in the six-month period.

This so-so performance reflects the Achilles' heel of Facebook's business model, which the company clearly stated in a list of risk factors associated with its IPO: it hasn't yet figured out how to advertise effectively on mobile devices. The number of Facebook users accessing the site on their phones surged by 67 percent to 543 million in the last quarter, or more than half its customer base.

Numbers are only part of the problem. The mounting pile of failure creates a negative feedback loop that threatens Facebook's future in other ways. Indeed, the more Facebook's disappointment in the market is catalogued, the more Facebook's image becomes tarnished. Not only does that threaten to rub off on users, it's bad for recruitment and retention of talented hackers, who are the lifeblood of Zuckerberg's creation.

Yet the wunderkind CEO can ignore the plaintive wails of his shareholders thanks to the super-voting stock he holds. This Rupert Murdoch-like arrangement also was fully disclosed at the time of the offering. It's a pity so few investors apparently bothered to do their homework.

Trending On Reuters

Markets

The BSE Sensex posted its worst monthly fall in more than two years, raising concerns a strong rally that saw indexes surge in the fiscal year was waning due to concerns about stock valuations and a more gradual economic growth. Full Article